Sources of Finance Unit 5: Financial Planning

1. Sources of FinanceUnit 5: Financial Planning Photo: © wrangler, shutterstock.comPhoto: © wrangler, shutterstock.com

2. Learning objectives

3. When does a business need finance?

4. Sources of finance

5. Internal sources of finance Teacher’s note: Retained profits – irrespective of the size of the business, there is always only so much retained profit available. If a business sees an opportunity for a major expansion, it may well not have enough retained profit to sufficiently cover costs. Owners’ funds – these are always likely to be limited and so a single owner might not have enough money to start the business by themselves in the first place. Moreover, if a business proved to be unsuccessful, the owner would lose his or her assets, as well as the business. Sale of assets – this is often seen as a backward step, although there are times (such as when a business will make more money selling their assets than keeping them on) when it makes good business sense to do this. However, it can also be difficult to actually sell the assets. Fixed assets are particularly difficult to sell on as they may be business-specific (machinery for example) and there may therefore be limited demand for them. Also, loss of such assets may adversely affect the productivity of a business, which is likely to put it into further difficulty. Photo: © Melissa King, shutterstock.comTeacher’s note: Retained profits – irrespective of the size of the business, there is always only so much retained profit available. If a business sees an opportunity for a major expansion, it may well not have enough retained profit to sufficiently cover costs. Owners’ funds – these are always likely to be limited and so a single owner might not have enough money to start the business by themselves in the first place. Moreover, if a business proved to be unsuccessful, the owner would lose his or her assets, as well as the business. Sale of assets – this is often seen as a backward step, although there are times (such as when a business will make more money selling their assets than keeping them on) when it makes good business sense to do this. However, it can also be difficult to actually sell the assets. Fixed assets are particularly difficult to sell on as they may be business-specific (machinery for example) and there may therefore be limited demand for them. Also, loss of such assets may adversely affect the productivity of a business, which is likely to put it into further difficulty. Photo: © Melissa King, shutterstock.com

6. External sources of finance

7. Short-, medium- and long-term finance

8. Owners’ funds

9. Retained profits

10. Selling assets Photos: © 2009 Jupiterimages CorporationPhotos: © 2009 Jupiterimages Corporation

11. Overdrafts Teacher’s note: You may wish to create a worksheet from this interactive by cutting and pasting the following text: Every business has a current account with a bank to pay for its day-to-day costs. Most businesses arrange to have overdrafts with their current accounts in case they ever experience unexpected cash flow problems. Overdrafts are a short-term source of finance and, generally, interest is charged on them. But the interest is only paid during the period in which a business is overdrawn. If a business's bank balance becomes positive again (no longer overdrawn) then it will stop paying interest. The advantage of an overdraft is that if a business falls behind with its repayments or it spends more than its agreed overdraft limit, the bank will not take its assets, although it may insist on full repayment of the overdraft.Teacher’s note: You may wish to create a worksheet from this interactive by cutting and pasting the following text: Every business has a current account with a bank to pay for its day-to-day costs. Most businesses arrange to have overdrafts with their current accounts in case they ever experience unexpected cash flow problems. Overdrafts are a short-term source of finance and, generally, interest is charged on them. But the interest is only paid during the period in which a business is overdrawn. If a business's bank balance becomes positive again (no longer overdrawn) then it will stop paying interest. The advantage of an overdraft is that if a business falls behind with its repayments or it spends more than its agreed overdraft limit, the bank will not take its assets, although it may insist on full repayment of the overdraft.

12. Loans Teacher’s note: As an extension activity, you may wish to ask students to choose three banks and research the loans offered to businesses. Banks include HSBC, Lloyds, Barclays, NatWest. Information about them can be found at these addresses: www.hsbc.co.uk/1/2/business/finance-borrowing;jsessionid=0000HoSLR8UK9oUn60jFgOOzvbT:11j56r6g2 www.lloydstsbbusiness.com/finance/businessloan.asp www.business.barclays.co.uk/BRC1/jsp/brccontrol?task=homefreevi2&value=11367&target=_self&site=bbb www.natwest.com/business02.asp?id=BUSINESS/BORROW/LOANS These weblinks were working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites. Photo: © 2009 stock.xchng Teacher’s note: As an extension activity, you may wish to ask students to choose three banks and research the loans offered to businesses. Banks include HSBC, Lloyds, Barclays, NatWest. Information about them can be found at these addresses: www.hsbc.co.uk/1/2/business/finance-borrowing;jsessionid=0000HoSLR8UK9oUn60jFgOOzvbT:11j56r6g2 www.lloydstsbbusiness.com/finance/businessloan.asp www.business.barclays.co.uk/BRC1/jsp/brccontrol?task=homefreevi2&value=11367&target=_self&site=bbb www.natwest.com/business02.asp?id=BUSINESS/BORROW/LOANS These weblinks were working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites. Photo: © 2009 stock.xchng

13. Government grants Teacher’s note: As an extension activity, you may wish to ask students to conduct some research into the different types of grants that are available to businesses. Some useful websites for conducting this research can be found at these addresses: www.smallbusiness.co.uk www.dti.gov.uk/ These weblinks were working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites.Teacher’s note: As an extension activity, you may wish to ask students to conduct some research into the different types of grants that are available to businesses. Some useful websites for conducting this research can be found at these addresses: www.smallbusiness.co.uk www.dti.gov.uk/ These weblinks were working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites.

14. Hire purchase and leasing Teacher’s note: As an extension activity, you may wish to ask the students to research the cost of buying a Ford Transit van versus hiring or leasing one. Ask them to think about the advantages and disadvantages of each method, e.g. buying is cheaper in the long term but it is expensive at first, and the business would have to pay for the repairs. Hiring would be more expensive in the long term but the payments would be spread out and the business would own the van at the end of the term. Leasing a van would spread the cost and the leasing company would pay for repairs, but leasing would work out to be the most expensive in the long term as the business would not own the asset at the end of the term. Photo: © 2009 stock.xchngTeacher’s note: As an extension activity, you may wish to ask the students to research the cost of buying a Ford Transit van versus hiring or leasing one. Ask them to think about the advantages and disadvantages of each method, e.g. buying is cheaper in the long term but it is expensive at first, and the business would have to pay for the repairs. Hiring would be more expensive in the long term but the payments would be spread out and the business would own the van at the end of the term. Leasing a van would spread the cost and the leasing company would pay for repairs, but leasing would work out to be the most expensive in the long term as the business would not own the asset at the end of the term. Photo: © 2009 stock.xchng

15. Issuing shares Photo: © 2009 Jupiterimages CorporationPhoto: © 2009 Jupiterimages Corporation

16. Venture capital Teacher’s note: In Dragon’s Den, entrepreneurs pitch their ideas to venture capitalists in a bid to try and secure investment finance from them. Further information about Dragon’s Den, the venture capitalists on the programme and video clips of them interviewing small start-up businesses can be found at this address: www.bbc.co.uk/dragonsden/ This weblink was working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites. Photos: © 2009 Jupiterimages CorporationTeacher’s note: In Dragon’s Den, entrepreneurs pitch their ideas to venture capitalists in a bid to try and secure investment finance from them. Further information about Dragon’s Den, the venture capitalists on the programme and video clips of them interviewing small start-up businesses can be found at this address: www.bbc.co.uk/dragonsden/ This weblink was working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites. Photos: © 2009 Jupiterimages Corporation

17. Factors affecting choices Teacher’s note: As an extension activity, you may wish to ask students to visit the Bank of England’s website and draw a graph to map the changes in interest rates over the last two years. Information about the Bank of England can be found at this address: www.bankofengland.co.uk/ This weblink was working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites.Teacher’s note: As an extension activity, you may wish to ask students to visit the Bank of England’s website and draw a graph to map the changes in interest rates over the last two years. Information about the Bank of England can be found at this address: www.bankofengland.co.uk/ This weblink was working correctly at the time of publication. Boardworks takes no responsibility for the content of external sites.

18. Question time Suggested answers: Businesses need to raise finance when they are starting up, are having cash flow problems, need to renew or update their operations or want to expand. The main types of internal finance are owners’ funds, retained profits and the sale of assets. The different types of external finance are short-term, medium-term and long-term. The factors that affect a business’s choice of funds include the amount of money needed; the cost; the risk involved; whether the funding is needed in the short-, medium- or long-term; whether the business is willing to relinquish control of its affairs; and whether the business is happy to take advice. One advantage of using owners’ funds is that the owners keep total control of their business; a disadvantage is that if the owner secures an asset to raise the funds (e.g. by re-mortgaging their own homes) they may lose that asset if they can’t keep up with the repayments.Suggested answers: Businesses need to raise finance when they are starting up, are having cash flow problems, need to renew or update their operations or want to expand. The main types of internal finance are owners’ funds, retained profits and the sale of assets. The different types of external finance are short-term, medium-term and long-term. The factors that affect a business’s choice of funds include the amount of money needed; the cost; the risk involved; whether the funding is needed in the short-, medium- or long-term; whether the business is willing to relinquish control of its affairs; and whether the business is happy to take advice. One advantage of using owners’ funds is that the owners keep total control of their business; a disadvantage is that if the owner secures an asset to raise the funds (e.g. by re-mortgaging their own homes) they may lose that asset if they can’t keep up with the repayments.

19. Who wants to be an A* student? Answers: Retained profits An overdraft Hire purchase Venture capital Security Assisted areas Must return it Dividends Share price Hostile takeoverAnswers: Retained profits An overdraft Hire purchase Venture capital Security Assisted areas Must return it Dividends Share price Hostile takeover

20. Glossary Teacher’s note: To test students’ understanding of the topic, you may wish to ask them what each word in the glossary means before pressing to reveal the definition. Alternatively, you may wish to set students an extension or homework activity to research and define the terms. The definitions provided here can be used as an additional point of reference once they have completed the task.Teacher’s note: To test students’ understanding of the topic, you may wish to ask them what each word in the glossary means before pressing to reveal the definition. Alternatively, you may wish to set students an extension or homework activity to research and define the terms. The definitions provided here can be used as an additional point of reference once they have completed the task.